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Hong Kong’s official currency is the Hong Kong Dollar (HKD). The Hong Kong Monetary Authority (HKMA) is responsible for monetary policy.
There are no restrictions as to the holding of foreign currency in Hong Kong.
The HKMA has a mandate to maintain currency stability only, and this is achieved through a fixed exchange rate with the US dollar. There is no inflation target in Hong Kong. This means that the HKMA may allow deflation or high inflation if it is necessary to maintain the US dollar peg.
Interest rates in Hong Kong have stayed at near-zero levels since the 2008 crash. Such low borrowing costs are a key component of Hong Kong’s dovish monetary policy. Because of the fixed exchange rate, interest rates are unlikely to move until and unless US monetary policy tightens (i.e. probably not before US unemployment shrinks below 6.5%).
Dovish monetary policy is in line with the current international trend. Hong Kong’s borrowing costs are thus broadly similar to those of most major countries. As Hong Kong’s monetary policy is determined by the US dollar peg, the HKMA may provide monetary stimulus even if the Hong Kong economy doesn’t really need it. Higher inflation, higher GDP growth and real appreciation may result from loose monetary policy.
Exchange rate regime
The Hong Kong dollar is pegged to the US dollar. The USD/HKD exchange rate has always stayed within the 7.75-7.85 range since 1983. The US dollar peg is called the “Linked Exchange Rate System” in HKMA jargon.
Prior to that date, the Hong Kong dollar was much higher (up to 70% firmer) and the exchange rate was not as pegged as today. In the early 1980s, the Hong Kong dollar was subject to an uncontrollable depreciation, which didn’t stop until the peg was imposed.
Due to the US dollar peg, your applicable HKD exchange rate is positively correlated with your applicable USD exchange rate.
Emma comes from Germany, and she’s wondering about her applicable EUR/HKD exchange rate.
Emma will have to monitor the developments in the EUR/USD exchange rate. Any EUR/USD rise mechanically involves a EUR/HKD rise, and vice versa.
If, for example, the US economy is resilient enough to afford interest rate rises while the Euro-zone economy lags, the US dollar may appreciate versus the euro. Hence, EUR/USD and EUR/HKD declines are likely.
This reasoning will have to apply for so long as the US dollar peg is in place.
Pegged or fixed exchange rate regimes do not allow macroeconomic factors to be priced in the exchange rates. As a result, they can cause macroeconomic instability of various forms. Hence, they are no longer common practice among developed economies, which would rather have floating exchange rates to let the markets price in macroeconomic factors.
Expatriates should therefore be careful before relying solely on the pegged exchange rate. Although no significant threat to the US dollar peg has been reported for the foreseeable future, it is advisable to monitor the developments regarding this matter.
No HKD monetary base expansion may take place unless it is fully backed by US dollar reserves at the HKMA. Consequently, the HKMA has very large reserves to address any potential downside pressure on the Hong Kong dollar, which is very good for financial stability.
Impact on inflation
If macroeconomic fundamentals favour Hong Kong, the HKMA normally has to expand the HKD monetary base in order to defend the USD/HKD exchange rate (otherwise, USD/HKD would go down). Thus, this creates monetary stimulus and inflationary pressure in Hong Kong. Conversely, if Hong Kong’s economy shows persistent slack, the HKMA has to reduce the monetary base to defend the exchange rate (otherwise, USD/HKD would go up). In that case, the net effect is monetary tightening and deflationary pressure in Hong Kong.
Note that HKMA interventions are pro-cyclical, i.e. they may aggravate Hong Kong’s macroeconomic trends (either way).
In a fixed exchange rate regime, real appreciation may still take place if inflation rates do not match. If inflation rates for the US and Hong Kong are 2% and 4% respectively, there is a real appreciation of the Hong Kong dollar. In effect, US goods become cheaper.
In the 2000s, the Hong Kong dollar persistently depreciated in real terms. This trend reversed since the 2008 financial crisis, as the Hong Kong dollar now constantly appreciates in real terms.
The US/Hong Kong macroeconomic mismatch, although real, has not been big enough to create major financial instability so far.
Sections in FINANCIAL CONSIDERATIONS IN HONG KONG:
» Money Transfers for Expats in Hong Kong
» Foreign Exchange for Expats in Hong Kong
» Banking for Expats in Hong Kong
» Pensions for Expats in Hong Kong
» Investment for Expats in Hong Kong
» Wealth Management for Expats in Hong Kong
» Property Investment for Expats in Hong Kong
» Insurance for Expats in Hong Kong
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